For the past several decades, fair value accounting becomes main method of measuring assets and liabilities. This marks a major different from the centuries-old tradition of keeping books at historical cost. It also has implications across the world of business, because the accounting basis-whether fair value or historical cost-affects investment choices and management decisions, with consequences for aggregate economic activity. The argument for fair value accounting is that is it . Fair value accounting was blamed for some dubious practices in the period leading up to the Wall Street crash of 1929, and was virtually banned by the U.S. Securities and Exchange Commission from the 1930s through the 1970s. The 2008 financial crisis brought it under fire again. Some scholars and practitioners have connected its proliferation in accounting-based performance metrics to the actions of bankers and other managers during the run-up to the crisis. Specifically, as asset prices rose through 2008, the fair value gains on certain securitized assets held by financial institutions were recognized as net income, and thus sometimes used to calculate executive bonuses. And after asset prices began falling, many financial executives blamed fair value markdowns for accelerating the decline.
The author argues that the fair value accounting required by the international standard on financial instruments (IAS 39) will institutionalize 'false accounting on a global scale' and gives a numerical example to show how it can mislead accounts users. Believes that reporting an increase in present value as a gain or loss is wrong, since opportunities are not the same as transactions; and that the market value fallacy has contributed to the pensions crisis and the housing bubble. Quotes the UK Theft Act 1968 to show that reporting misleading gains is a breach of criminal law and sees IAS 39 as 'calculated to bring the profession into disrepute'1.2 Aims
In this report, it tries to explain that what Fair value in IFRS13/AASB13 is; how are assets and liabilities valued under the Fair Value accounting system. It also compares the different between historical cost and fair value accounting. Argue how the Income Statement and Balance Sheet affected by the Fair Value accounting system; is there any change in assets or a change in income resulting from applying the Fair Value accounting. Thinks about what is the fundamental value in accounting.
2. Discussions
2.1. What are the essential features of the 'Fair value' accounting as laid out in IFRS13/AASB13 Fair Value? How are assets and liabilities valued under the Fair Value accounting system?
IFRS 13 Fair value measurement establishes guidance that fair value measurement is a single source required under IFRS; sets out a framework about how to measure fair value for financial reporting purposes and requires enhanced disclosures about fair value measurements. (McCarroll & Khatri 2012). Under AASB 13(2011) and IFRS 13(2012), they define fair value on the basis of an 'exit price' that would be received from selling an asset or paid to transfer a liability at the measurement date. That definition emphasises that fair value is a market-based measurement, not an entity-specific measurement. In another words, the fair value of a financial liability is the amount at which it could be settled between knowledgeable, willing parties in an arm's-length transaction. As a result, an entity's purchasing a non-current asset is not relevant when measured by fair value. (Godfrey, et al 2010).
Maris (2013) indicates that, the Key features of AASB 13 in determining fair value are including as follows:
• Use of exit market (principal or most advantageous)
• Highest and best use for non-financial assets
• Block discounts not permitted
• Liquidity considerations incorporated into the valuation
• Liabilities and equity instruments considered from the perspective of market participants who hold these as assets
• New disclosures.
Sections 11 to 14 of AASB 13 settle the principles about fair value measurement for a particular asset or liability. When measuring fair value an entity shall take into account the characteristics of the asset or liability if market participants would take those characteristics into account when pricing the asset or liability at the measurement date. Such characteristics include, for example, the following: (a) the condition and location of the asset; and (b) restrictions, if any, on the sale or use of the asset.
12 The effect on the measurement arising from a particular characteristic will differ depending on how that characteristic would be taken into account by market participants.
13 The asset or liability measured at fair value might be either of the following: (a) a stand-alone asset or liability (eg a financial instrument or a non-financial asset); or
(b) a group of assets, a group of liabilities or a group of assets and liabilities (eg a cash-generating unit or a business).
14 Whether the asset or liability is a stand-alone asset or liability, a group of assets, a group of liabilities or a group of assets and liabilities for recognition or disclosure purposes depends on its unit of account. The unit of account for the asset or liability shall be determined in accordance with the Standard that requires or permits the fair value measurement, except as provided in this Standard.
2.2. According to Rayman, how is the Income Statement and Balance Sheet affected by the Fair Value accounting system?
Any gain or loss is recognised in the income statement and the financial instrument is valued at fair value in the balance sheet.
the income statement which is considered the primary financial statement, results from matching an entity's revenues with expenses during a period of time, and it conveys useful information of a company's performance and shareholders' value. On the other hand, the balance sheet is regarded as a by- product of the matching process including such unearned revenues, accrued expenses, prepaid expenses, and accrued revenues (Casabona & Gornik- Tomaszewski, 2007).
International Financial Reporting Standards (IFRS) is a set of accounting standards developed by International Accounting Standards Board (IASB), has gradually become the globalization guidelines in preparing the financial statements for listed companies. IASB is an independent, privately funded accounting standards- setter based in London, England.
Casabona & Gornik- Tomaszewski (2007) state that FASB has been adding more fair value recognition, measurement, disclosure standards to the body of IFRS adopted countries such UK generally accepted accounting principles (UK GAAP). FASB follows a similar approach. Thus, a mixed accounting system has been created and developed, which the historical cost still the primary base but with an ever increasing application of fair value accounting. As a result, a shift has occurred towards using the balance sheet instead of the income sheet as the primary financial statement conveying information to shareholders, and the income statement reporting economic income as simply the change in value over a period of time.
2.3 How does Fair Value accounting contradict with the Historical Cost accounting? (4 marks)
For Historical Cost the company carries the asset on the balance sheet at the purchase cost less any depreciation taken. At the time of sale, the company records a gain or a loss against the purchase cost of an asset less any depreciation if applicable. In another words, assets on the balance sheet are recorded at historical costs until sold. The historical cost principle follows the accounting quality of reliability since everyone can agree on the original purchase price of an asset.
The measurement requirement is that profit is only measured when an external transaction is realised. Departure from the realisation principle is covered in the criticism section. The problems are:
liquidation vs. going concern concept
recognition before confirmation by sale
definition of profit and meaningful profit
problems of obtaining selling prices
value in use concept of an asset.
Raymon pays particular attention to the concept of realisation. Comments such as 'the relevance of a value change being a measure of financial performance is the result of a fallacy deeply entrenched in the conventional academic wisdom, and 'the fundamental mistake is to report value change as a gain or loss'; summarise his position.
2.4 Are the changes resulting from applying the Fair Value accounting principles a change increase/decrease) in assets or a change (increase/decrease) in income? Is change in assets and change in income the same thing? Why, or why not?
Of course this is a debate that has occurred amongst financial accounting theorists for nearly a century. Rayman uses the return on investment argument and no adaptive behaviour to support his case. That is if interest rates fall and investors do not realise the capital gain, then they are no better off. This is true as the rate of return has dropped to 5.5% from 8% and no realisation has occurred. However, the opportunity is there to realise the investment and adapt the investment to other classes of assets which will benefit from a fall in interest rates (e.g. stock market, housing). Is unrealised income an increase in wealth or income or not is answered by economists who define increases in wealth as income. Not all accountants agree. What does the general public think? Using the illustration of the recent housing boom can provide a case study. Certainly most people saw the increased prices as an increase in wealth and either realised the value or else used their greater equity to borrow and consume, thus fuelling recent consumer spending. Other case studies can be used by the instructor in this debate.
2.5 How does 'value in exchange' differ from 'value in use'? Which of the two should be the fundamental value in accounting? Why?
In Marx's critique of political economy, any labor-product has a value and a use-value, and if it is traded as a commodity in markets, it additionally has an exchange value, most often expressed as a price.
Value in use is the utility of consume service in classical political economy.The worth of a property in a certain use, typically a good; the want-satisfying power of a good or as it is currently being used. This amount may be greater or less than its market value. it is the net present value (NPV) of a cash flow or other benefits that an asset generates for a specific owner under a specific use.
Value in exchange means that value, which is satisfaction, is obtained indirectly through the acquisition of something else. It is the amount of other assets, goods and services for which a unit of a specific good can be exchanged in a market. The price often is one measure of value in an exchange. For an item to have value in exchange it need NOT have value in use, value obtained directly from the consumption of a good or service, such as the money.
If the firm has assets that are mixed - financial, operating, intangible - then valuation would require the utilisation of different fundamental value concepts. This appears to be the way that standard setting bodies are headed. However, the problem is that the conceptual nature of the system becomes more and more complex and the solution more vague. Moreover, any standard that attempts to address the problem gives the impression that the output is a result of compromise rather than being driven by one conceptual general model. Moreover, users must be sophisticated enough to understand that different components of fundamental value and because the solution may be a mixed system, the additive principle may be questioned.
6. Conclusion
In the discussion part, it completely explains the competition and challenges for RTE. At the same time enumerates different types of Information System, analyses the advantages and disadvantages to summarize the best system for RTE.
7. Recommendations
Due to the complexions of RTE, it is recommended that to choose the CRM and SCM system and set up a small e-business is good for RTE.
